Eisman: Ocwen, Up 170% in a Year, Has More Juice

by Suzanne McGeeMay 13, 2013

Steve Eisman of Emrys Partners made his name and a small fortune by selling short the U.S. housing market (or, more specifically, correctly betting that securitized subprime mortgages were heading toward catastrophe). So when he took the podium at this year’s Ira Sohn Conference in New York to chat about his favorite stocks, the fact that many of them were plays on the U.S. housing market was an interesting twist – and may give investors an extra degree of confidence that the housing recovery that was such a big source of return last year may not have run its course.

But Eisman’s favorite housing-related play wasn’t one of the stocks that has become a household name because of its direct exposure to homebuilding, like Lennar (LEN) or Pulte Homes (PHM). It’s not that he doesn’t like those two stalwarts: on the contrary, he hails the former’s land holdings and the latter’s valuation, or PE ratio. But his favorite from amongst the ranks of housing-related plays isn’t a home builder, or even one of the banks that has profited from last year’s boom in mortgage refinancing, but rather the relatively obscure Ocwen Financial (OCN), which he described as being “perhaps the most powerful yet most counterintuitive play on housing.”

Ocwen, whose stock price has soared an astonishing 170% over the last 12 months, as seen in a stock chart, is a mortgage servicing company, collecting payments from homeowners on behalf of lenders. As some of the biggest banks, like Bank of America (BAC), have scaled back their activity in this area, Ocwen has become part of a group of companies that is seizing the opportunities created by new regulations and capital rules that make certain kinds of businesses that the biggest banks once owned or dominated impossible, less profitable or otherwise cumbersome.

Earlier this year, Ocwen picked up the rights to service about $90 billion of mortgage loans from Ally Financial Inc., the bankrupt financial institution now controlled by the U.S. Treasury and that failed its most recent stress test. Separately, Ocwen has teamed up with a rival, Walter Investment Management Corp. (WAC) to pay $3 billion for other servicing and origination assets from a division of Ally Financial. The company also has snapped up Liberty Home Equity Solutions from Genworth Financial (GNW); collectively, these deals have helped transform it into one of the largest mortgage-servicing companies in the nation. Better yet, it’s fairly safe to assume that Ocwen knows what it’s doing in the world of distressed investing: its board includes Wilbur Ross, one of the foremost distressed/turnaround investors in this universe.

Eisman told the conference that he believes Ocwen remains “completely and utterly mispriced,” even in the wake of its outsize gains in recent months. Looking only at the company’s financials, it’s hard not to agree with Eisman. Ocwen trades at only 9 times its forward earnings, with a big jump in earnings expected; its trailing PE ratio is about 29. And its revenue growth greatly exceeds its increase in costs, thanks perhaps to the company’s emphasis on keeping its workforce offshore, with a majority based in countries like Uruguay and India. That helps to curb costs for what has traditionally been a rather pricey business – and has ensured that the rate of growth in Ocwen’s profits has been dramatic.

The one warning light investors may want to pay attention is on the regulatory front. While the company has done better than many of its banking peers on modifying loans, the entire mortgage and origination servicing industry is likely to remain a minefield for its participants, who will remain under scrutiny as long as there are homeowners whose loans are underwater. In 2012, the company settled a class-action lawsuit, paying $5.1 million even as it denied any wrongdoing with respect to overcharging borrowers who were late with their mortgage payments. New York regulators have persuaded the company to agree to have an outside observer oversee how it handles its servicing business, on an ongoing basis. Even without dramatic allegations of misdeeds or specific regulatory investigations to contend with, the odds are that the governance headaches with which the company and its investors must contend are only likely to increase.

That doesn’t mean that it won’t remain an interesting investment. As the big banks increasingly try to find ways to unload costly or burdensome businesses like mortgage servicing, pure play stocks like Ocwen will be waiting in the wings, and as long as it can keep its cost structure low and Americans remain as intent as ever on their dreams of home ownership, odds are that the company’s growth will remain impressive.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.